The earnings reporting season is just getting underway, and most U.S. companies haven't even told Wall Street how much money they made in the just-completed second quarter. But it's fourth-quarter profits that investors are really worried about.
The reason: For weeks, analysts have been slashing profit-growth estimates for the April-through-June quarter, as well as the current quarter. But not the fourth quarter. Profits are expected to fall 2% in the second quarter and rise 3% this quarter.
As a result, optimism has dropped a lot. The Dow Jones industrial average has shed nearly 300 points to 12,653 the past four sessions on fears about a profit pinch going forward from the fallout from Europe's debt woes, slowing growth in China and fresh signs of economic deceleration at home. Lowering the expectations bar for earnings could boost companies' chances of topping forecasts or cushion the blow for stocks if companies disappoint.
The risk? Fourth-quarter expectations remain robust. Analysts forecast profit growth of 14%, which could set stocks up for a steeper drop if soft economic conditions persist or worsen, and the lofty projections turn out to be too optimistic.
"The closer we get to the fourth quarter, the more concerned people will be," says Sam Stovall, chief equity strategist at Standard & Poor's.
If Europe's recession lasts longer than expected, China suffers a hard landing and U.S. growth dips further, it would dent earnings later in the year, Stovall says, creating a further drag on stocks.
Just how big a drag it could be is hard to quantify, says Gina Martin Adams, stock strategist at Wells Fargo Securities. "It depends on what other things are going on," she says. If profits are falling but economic news is improving or progress is being made on fixing U.S. fiscal problems, the downside for stocks would be limited, she says. But if profits are sinking along with the economy, stocks will likely suffer more.
Yet, with so much global uncertainty, it will be tough for companies to provide investors with an accurate outlook, says Citi economist Steven Wieting: "Investors will be misled if they think company guidance at this point can tell us what the distant future will look like."
This story first appeared in USA Today.